摩根士丹利 (MS) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Saxon Capital third quarter earnings conference.

At this time all lines are in a listen-only mode.

Later they'll be an opportunity for questions.

Instructions will be given at that time. [OPERATOR INSTRUCTIONS] I would like to turn the conference over to Vice President Investor Relations for Saxon Capital, Bobbi Roberts.

Please go ahead.

Thank you Cathy.

Good morning, everyone, and welcome to Saxon Capital's third quarter 2005 earnings conference call.

Joining me this morning is Mike Sawyer, our Chief Executive Officer and Rob Eastep, our Chief Financial Officer.

We issued a press release yesterday evening, which is available along with our summary of financial data on our website at www.saxoncapitalinc.com.

As is customary, I would like to begin with the following information on forward-looking statements.

Statements in this discussion reflecting our future plans and strategies are forward looking statements that are based on current expectations and assumptions.

These expectations and assumptions are subject to risks and uncertainties which could affect our future plan.

Saxon's actual results and the timing and occurrence of expected events could differ materially from our plans and expectations due to a number of factors.

We refer you to the press release issued yesterday, as well as, our annual report on form 10-K for the year ended December 31, 2004 for more information about factors that could effect our business and results.

You should be aware that all information in this discussion is as of November 8, 2005 and we undertake no duty to update any forward-looking statements.

With that I would like to turn the call over to Mike Sawyer.

Thank you, Bobbi and good morning, everyone.

I would like to begin our call today by addressing a few key areas, and how they relate to our third quarter performance.

For Saxon during the quarter, prepayment speeds maintained the rapid velocity nearing 40% as compared to 38% in the second quarter.

One month LIBOR increased during the quarter by 52 basis points and our margin continued to on decline albeit by a smaller amount as compared to a second quarter.

On the positive side, however our two and three portion of the swap curve has increased, which has had a positive effect on our hedging values.

We anticipate that these trends will continue through the remainder of 2005.

Since June 30th,Saxon as increased it's weighted average coupon on loans by approximately 90 basis points, and we're beginning to see these increases come through in the weighted average coupon on our production.

Overall our production increased from 7.3% from June to 7.6% for the month of October, and we're seeing our coupon on our commitments for November come in at an average of 7.9%.

We are encouraged by the recent pricing pleases in the marketplace.

During last quarter's call, we discussed our plans of accessing at the time the strong hold loan sale markets.

Our due diligence involved investment bankers, rating agencies and third-party credit reporting agencies, along with external validation to risk base pricing methodology and our product offerings in preparation for moving forward with the whole loan strategy.

However, during the third quarter we saw a significant negative shift in the economics of whole loan premiums, as credit spreads began to widen.

And from a Saxon standpoint, we did not see the economic benefit for us to participate in a whole loan strategy, as compared to the profitability of our portfolio model.

We were able to expand our product offerings in a limited manner during the quarter, as you'll see in our press release production statistics.

We're now originating the 40-year amortization mortgage product.

We continue to review our product offerings to ensure that we remain competitive in the marketplace, while maintaining our credit, underwriting and quality standards.

Also, as we mentioned in the second quarter call, our automated underwriting and pricing engine ideals was rolled out during the month of August.

The implementation of ideals allows us to move quickly in making product and policy changes.

Saxon is well positioned to introduce new products quickly and effectively.

We remain committed to reducing our general and administrative expenses and ultimately our net cost to produce.

We mentioned in the second quarter, many steps we have taken to increase our efficiency through automation.

And we are continuing down the path of realigning and refining our processes and work flows to create more efficiencies.

Overall, the G&A dollars from our production channels increased slightly by $1.5 million during the quarter.

Our net cost to produce increased primarily due to an increase in the correspondent premiums paid.

With that introduction, I would like to briefly discuss the quarter.

Saxon reported net GAAP income of $11.6 million or $0.23 per share on a diluted basis.

For the second quarter, total production increased 8% compared to the second quarter of 2005, and decreased 15% compared to third quarter 2004.

Year-to-date total production is down 11% from the same period a year ago.

Maintenance of our pricing discipline is the primary driver behind our reduced volume.

We have seen multiple competitors transact whole loan sales at below break-even pricing in the marketplace.

The recent increases in the market pricing, we're encouraged to see some rationalality beginning to re-emerge in the market.

Our net mortgage loan portfolio increased 1.6% since June 30, 2005 and 11% since September, 2004.

We continue to see a consistent and stable level of serious delinquent loans.

This quarter, serious delinquencies were 6.4% versus 6.6% a year ago.

Our portfolio continues to perform as expected and in line with historical seasonal trends.

Rob will provide more detail on Hurricane Katrina and its impact later in the call.

Also, during the quarter, we purchased third-party servicing rights to approximately $4.1 billion of mortgage loans.

As of September 30, 2005, our total servicing portfolio had grown to $26.5 billion, an increase of 64% from the same period a year ago.

With that overview, I would like to turn the the call over to Rob Eastep, our Chief Financial Officer to discuss the financial results in more detail.

Thanks, Mike.

Before I go into a lot of detail, I would like to take a few minutes during the call to provide color on some of the noise we saw in the numbers during the quarter.

First, approximately 2% of our portfolio was in the Gulf Coast states impacted by the Hurricane Katrina.

We have provided for $6.8 million or a $0.13 per share in our loan loss preserves for this quarter for the potential impact of Hurricane Katrina based on our best estimate.

We will continue to monitor our portfolio, contact our borrowers, and review our accounts to ensure we have the appropriate level of reserves for the impact of Hurricane Katrina.

Secondly, during the third quarter, we did experience temporary impairment to our MSRs for $3.4 million or $0.07 per share.

3 million was related to the continued fast prepayment speeds and general lower market valuations for our older third-party servicing portfolios and $400,000 was an impairment related to the the potential impact of Hurricane Katrina.

Overall, amortization impairment was 49% higher in the third quarter as compared to the second quarter of 2005.

Third, during the quarter, Saxon recorded a positive accumulative adjustment to income tax expense and our deferred tax asset of approximately $3.7 million or $0.07 per share.

This adjustment relates to the GAAP accounting treatment for income taxes related to inter-company transactions.

More specifically, to comply with the guidance as presented and the accounting research bulletin 51, consolidated financial statements.

Due to the sale of mortgage loans in advance receivables from the TRS to the [inaudible].

We must account for the prepaid taxes at the TRS and recognize the income tax expense or benefit when appropriate as determined by GAAP.

We've worked closely with our auditors and outside consultants to determine the proper method to recognize the income tax expense or benefit, and after a complicated and lengthy analysis, it was determined that our cumulative adjustment was required this quarter to align our GAAP statements with the guidance set forth in ARB 51.

Lastly, as we disclosed previously, we incurred approximately $2 million or $0.04 per share in severance cost for the quarter.

Now, I would like to discuss more of the details.

Our net interest margin after provisions declined to 2.2% from 2.4% at June 30th, excluding the impact of Hurricane Katrina.

As I mentioned, in our second quarter earnings call with the continued fast prepayment speeds and slower portfolio growth, we would expect to see this continued margin compression.

However, the compression has slowed down, as it was only 20 basis points versus 60 basis points compression in the second quarter.

With the increase in the two and three year swap curve in September.

We had a positive impact on the fair value of our hedges as is reflected in the higher balance of other comprehensive income at September 30, 2005, as compared to June 30, 2005.

We would expect this positively impact future quarters, assuming the value of our hedges at September 30, 2005.

Our total delinquencies increased $53 million from the second quarter, which is in line with seasonal trends and is less than the second quarter increase of $103 million.

Again, those numbers are excluding the Hurricane Katrina delinquencies.

From a chargeoff perspective, we're very pleased with the results as our portfolio continues to perform well within our credit expectations.

We continue to see lower losses on our 2003 through 2005 vintage portfolios come through our chargeoff numbers as compared to a year ago.

As a point of reference our GAAP chargeoffs were 8.6 million dollars in the third quarter of this year, versus 11.9 million for the same quarter a year ago.

The investment in the third party servicing generated gross service revenue -- third quarter of 2005 of 35.9 million or net of amortization and impairments of 19.1 million.

The net amount is an increase of 11% from the second quarter of 2005 and 128% increase from the third quarter 2004.

Let me now turn our attention to G&A expenses.

For the third quarter, our G&A dollars in production increased approximately $1.5 million, and we did see the G&A portion of our on net cost produce metric increase 2 basis points from the second quarter of 2005.

As our restructuring of our retail business took place midway through the second quarter, we are seeing effects of the building of our centralized retail platform, as we invest in new loan officers and marketing dollars.

We do expect to see improvement in future quarters as the efficiencies of a centralized retail platform materialize.

In our servicing channel, our G&A in dollars increased $1 million for the third quarter over the second quarter, but this increase was directly attributable to the growth in the portfolio as our cost of service remained stable at 17 basis points quarter-to-quarter.

In our administration area, we did see an increase of a little over $1 million through the third quarter from the second quarter due to primarily increases in cost related to information technology projects which will be providing operating efficiencies in future quarters.

This excludes the $2 million severance charge which are recorded with administrative cost.

Our capitalized expenses were deferred to direct loan origination costs did decrease significantly in the third quarter from the second quarter due primarily to the lower cost platform in retail.

The amount of the decrease was $1.2 million or approximately 14 basis points based on third quarter volume.

Lastly, other expenses increased approximately $1.6 million due primarily due to expenses related to REO properties.

In the second quarter, the Company had net recoveries related to REO properties.

We would normally anticipate other expenses to run in the 2.5 to $2.9 million range.

To sum up the quarter, we're seeing the market pricing conditions adversely affect our earnings.

Our investment in G&A for the quarter, our expected are drive future revenue growth in our servicing and retail channels and our investment and information technology is expected to drive future operating efficiencies, and all of our origination platforms.

With that, I would like to turn the call back over to Mike.

Thank you, Rob.

Before we open up the call to Q&A for our listeners, I would like to say we continue to look at our operations from top to bottom in a constant effort to improve work flow processes, and we will invest our dollars to improve technology and drive efficiencies.

I would now like to turn the call over to our operator so we can take any questions from our listeners.

Thank you. [OPERATOR INSTRUCTIONS]

Our first question comes from Rick Shane with Jefferies.

Please go ahead.

Good morning, guys.

Two questions.

Really on the expense side.

Rob you had made the comment that you expect that origination cost will start to decline once you benefit from those efficiencies, but you said that's in at future.

Can you give us some sort of time line so that we can dial in our models?

I'm assuming this is not a fourth quarter or first quarter event at this point given how competitive it is for volumes, but can you talk about when you think that we might start to see some cost benefits?

Actually Rick, I think on the retail side, we're going to start seeing some benefits coming in in the fourth quarter.

If you look at our -- the trending on a month to month basis,we are seeing month over month in efficiencies and our net cost produces on the retail channel.

As we continue to see the growth in our retail channel, we do expect to see the benefits come through in the fourth quarter.

Overall, when you're looking at wholesale correspondent, some of the technology investments that's we're making -- that we continue to make, we're probably looking at more of a 2006 first, second quarter of 2006, to really start seeing those benefits.

But, I think, from the retail restructuring, we are seeing that efficiency come through, and I think, we would expect to continue to see that come through in the fourth quarter immediately, with the other on two channels from a technology standpoint coming into the 2006.

Got it.

And related to that, you mentioned the million dollars of incremental G&A for technology.

It sounds to me look we should to expect that sort of run rate for the next couple of quarters?

I think so.

Some of the technology that we're making is to investments that we're making from a technology standpoint, but also has impact on work flow, as Mike mentioned.

And we have on tap probably the fourth quarter -- halfway through 2006, probably see that level of technology investment.

Got it.

And one last question.

The 1.9 million of severance, is that related just to the two employees who were let go or were there other work flow -- or work force adjustments that have been going on?

That was specific to the two employees that we had disclosed previously.

Okay, thank you, guys.

Your next question is from Scott Valentin with Friedman, Billings, Ramsey.

Please go ahead.

Good morning, thanks for taking my question.

Hi, Scott.

One question.

I guess I was trying to reconcile, you guys mentioned that the whole loan bids had come down in the third quarter, and I guess the fourth quarter we'll probably see even lower whole loan bids, more coupons were in the third quarter on originations.

I guess I was trying to reconcile, it looks like the cost increased because of the correspondent business?

I guess I thought the whole loan bids going down would help the correspondent cost originate?

What's happened, Scott, is that as you know how the correspondent business works, it's a is secondary market transaction.

And given where par rates in the marketplace have been, it gave some of our correspondents room to originate loans at a higher rate which increased the premiums that we paid.

Now, while we pay premium and take the expense up front, we don't get the benefit of the higher coupon until the loan goes into portfolio and matures over time.

But that premium was not such a reduction in our return as it was an increase in the coupon over our par rate.

On the whole loan sale though in the open marketplace, you know, we saw over the last several months, we saw several large whole loan transactions in the 1 billion to $2 billion range trade at barely basis points over par, and I don't care how efficient you are, you cannot convince me that that's a profitable way to do business.

However, that is where some of our market leaders have been originating product at.

We have with us today, Ernie Batona, who is our Senior VP of Capital Markets.

Ernie just got back from the Merrill Lynch conference out in California last weekend.

Ernie you want to talk about when you're seeing it today.

I know you gave us some color this morning.

Sure, Mike, thank you.

We've seen in movement from the lows I would say in whole loan prices.

I mean, today, you're probably seeing on a release pool roughly around a 101.5 and that's a positive trend to what you've seen in the past.

The trend is moving upward as the marketplace increases coupons.

I expect if that trend continues, we could see whole loan prices grow further than that.

We have seen over the last three weeks, Scott, competitors, especially, large competitors, make consistent increases in their par pricing and for the first time, at least over the last two weeks, the increases have been greater than movement in the swap curve and cost of funds.

Okay.

So on the positive side, people are finally looking at profitabilities as opposed to volume?

Absolutely.

The second question, I guess, I think it's in the context of things improving, it becomes a little trickier.

People look at the stock and say it's 74% of book value due to high prepayment speeds the portfolio is now growing, so you guys remain somewhat under levered and people look at the buyback and and say why wouldn't you do a buyback at this point?

That's a question that comes up all the time.

We look at it and discuss it both as management and with our board.

At this point and time, we are not prepared to make any announcement regarding that.

I would say, though, as you have heard me on calls consistently over the last year, expecting the changes that we've seen in the marketplace occur, one of the reasons we raised additional capital last year was that we were fully expecting to see marketplace react in this manner when rates started to turn.

So right now, I'm looking at the long-term as always, and we're focused on capital preservation and reducing our cost to produce and investing our capital where we get the highest return.

As you can see in the growth of our servicing business over the past year, we have invested our capital at a fairly, fairly decent rate and we are getting an excellent return in that servicing business.

Okay, and one thing --

I would like to correct one fallacy.

In terms of comparative growth, you are correct that our portfolio is not returned .But even last year, when we left to marketplace, we spoke about consistently growing about 10 to 15% a year, and we were up 11% year-over-year in our portfolio despite 40% CPR speeds.

Okay, fair enough.

Question on Katrina.

The $6. million charge, if I do back the envelope calculation, you said 2% of the portfolio was in affected areas.

Does that imply almost like you're assuming a 6% loss rate on those assets?

Using -- we're not using our own metrics for that, we are using the Balboa Insurance, which is a primary flood insurance providers there.

So day-by-day, this is one of the reasons our earnings announcement was a little bit late, is day-by-day we're getting access to the properties and finding out that even through they were in the flood area, they're no flood damage and in fact, the customers are paying us.

So it's probably going to be several months for this to work out.

We feel that our reserve is a prudent reserve.

We feel that it's in the middle area of the range of potential losses as GAAP recommends.

And we are very comfortable that is absolutely the most effect we would see from Katrina, and we hope that it would not be that bad, but as we always do, when we find something that we realize has an impact, we address it immediately and conservatively.

Mike, let me add just a little color on that.

You know the 2%, of UPB that's affected in that, you know that is kind of, you also have to take consideration that a number of those houses are not in the flood area, and they had wind damage, and we have property insurance for those, so the reserve that we based it on is primarily related to loans that were -- that had flood damage but were not covered by flood insurance because they were outside the 100-year plain or the 100-year flood zone.

So primarily that the reserve is related to loans that had flood damage but no flood insurance.

Any loans that we had that had wind damage, or hurricane damage that would be covered under property insurance, we will get proceeds from those.

Okay, thank you.

We'll now go to Bose George with KBW.

Please proceed.

Good morning.

Good morning, Bose.

How much did you pay for the servicing that you purchased in 3Q?

And what kind of returns you getting on the purchase servicing?

Also, do you see opportunities to keep purchasing at that 4 billion or so level going forward for a little while?

Our premiums have been consistent throughout the first three quarters.

Our expectations are that premiums may rise.

As the marketplace begins to increase coupons in response to rising interest rates, I think, it's a general consensus in the marketplace, that volumes will begin to contract.

By definition that means that pricing for the servicing rates will rise.

We do expect that we will be able to maintain our advantage in terms of purchase price, primarily based opinion the continued excellent performance of our servicing platform and the desire to maintain or reduce the current concentration in terms of servicers, where Saxon is a relatively smaller market share number.

Now, for the quarter, Rob. 66 basis points, as opposed to 68, I believe, in the second quarter.

So it's been fairly consistent.

We currently do not see any problem in maintaining the level of our purchases.

In terms of the returns on that, can you give a ballpark in terms of ROEs or IORs, or however you look at?

We look at it more on an IOR basis, because we exclude our own portfolio and we look at the third-party business as a separate business, and Rob, I'll let you talk to those numbers.

George, you're looking on a pretax basis, a return of in the mid to high 20's, on our pretax basis.

That's on an unlevered basis.

We have the ability to lever those servicing receivables at about a 2 to 1 ratio.

Thanks a lot.

[OPERATOR INSTRUCTIONS] And we have a question from David West with Davenport and Company.

Please go ahead.

Thank you.

Good morning.

Good morning, Dave.

Just kind of a follow-up to one line of discussion.

Earlier we talked about the insurance related process.

Thus far, have you already gotten any insurance proceeds or the underlying insurance companies generally being fairly cooperative thus far or is it too early to tell?

We are seeing proceeds coming in.

Obviously, it's pretty early in the inspection process, but we are seeing some proceeds kind of dribble in.

But as far as the insurance companies go, I think the process has gone pretty well.

Over the last month have been able to get in and get property inspections on our portfolio.

Yeah, I think the thing that people have to take into consideration, the magnitude of it.

But I think as far as how much everybody is focused on it and stuff.

I think from the insurance company's standpoint, we're getting as much corporation as could be expected based on the magnitude of the devastation down there.

Great.

Great.

You noted in your press release and your remarks, you had a nice positive impact on the swap curve, in terms of your mark to market and runging through OCI.

To what extent did that benefit your third quarter earnings and I guess lowered your cost of funds by what magnitude?

I think the end of the third quarter was about 7 basis points would have been the reduction in our interest expense related to that.

What you had in the second quarter or in the third quarter is if you recall back in August when hurricane came it's actually the bond prices dropped and the value of our swaps dropped in relationship to the bond curve -- the bonds.

So we actually ended up with hedge losses in August but then the market recovered immediately in September and stuff and the swap curve steepened in September and we picked up a substantial amount of value.

We had on average about 7 basis points of pick up in the third quarter.We do expect, assuming that the market doesn't change from the September 30th balances, that we'll continue to see significant benefit from the hedge positions.

As of today, the hedge values -- with the season two and three are [indiscernible] have even increased more in value.

But the third quarter -- second quarter, we had a negative OCI balance of $684,000 and the end of third quarter we had OCI balance of $20 million.

That pick up that we had in hedge value should positively impact fourth quarter and into 2006.

The reason for that again, Bose, is that we mark to market and accrete those on a monthly basis throughout the quarter.

So as Rob said, when the return came through, bond market was expecting fed stimulus and that had a short time temporary effect on the value of the hedge portfolio.

Very good.

As prepayment rates as they continue with these relatively high levels, that would in theory allow you to accrete this value into extreme even faster?

Absolutely, correct.

Just one clarification.

When you talking earlier about your hopefull improvement in production costs, were you talking about a potential absolute decline in dollar terms in the fourth quarter or -- an improvement in your origination levels or was it a combination of each?

I think David, it's going to be a combination of each.

When you look at it on the retail side, specifically as -- our goal on that was to increase the volume growth at a lower cost to originate, but the other channels and corporatively, as Mike mentioned, we're looking at the our processes and our efficiencies to help drive down the absolutely dollar cost.

So you may have a shift of dollars going on, because you do want to continue to invest in the consolidation and the centralization of the retail platform.

Thank you very much.

Thank you.

We'll go to Jim Agol (ph) with Millennium Partners.

Good morning, guys.

I just wanted you to go into the cost to originate in more detail.

When we had talked between the second and third quarters at investor meetings.

I was under the impression, now it's the wrong impression, obviously, but I was under the impression, that you guys were going to see about a 25 million decrease year 2005 over 2004 origination costs?

And that you were targeting ultimately a 2 to 2.25% CTL.

Now, are you just pushing this out or are we never going to get there?

That's question number one.

And maybe you could follow-up on -- you said that there were people hired?

You had to bring in some people.

So, on one hand we're experiencing severance for a couple of the executives that were let go and on the other hand we're hiring more people.

Maybe you can talk about that as well.

Jim, let me go to the first one.

First of all we did have several one-time expenses in the quarter, again, that kind of clouded things, okay.

Yes.

In terms of where our target is, we are definitely focused on and maintain our goal to get to that target.

I do believe that we will get there faster than what this last quarter showed.

We continue to work internally at analyzing our cost up and down the organization from the top all the way down.

In terms of hiring people, the additional people that we had were primarily loan officers in the retail in the centralized branches and collectors on the servicing business.

In terms of management and additional costs there, we did have a relatively large one time adjustment, which relates to GAAP in -- you know our lease expired on our old building and we moved to the building next door, and they made us take all future expected increases over the 12-year term of the lease and amortize it back to the time of possession, which they define as when we started pulling cables in the building, which meant that we had about a half a million dollars of lease expense over GAAP that had nothing to do with our monthly rent payment.

So that also was a measurable impact in the quarter that was a GAAP number but not necessarily a taxable or a cash flow number.

Now in terms of how do we get where we're going?

One of the technology investments that we're making is we are bringing our loan origination system or LOS up into the modern ages so that it can connect with and help us increase our processes and our efficiencies in terms of getting the loans through the system faster.

That -- if you're not aware of what a servicing system conversion system looks like or a loan origination system conversion, it takes several months and several million dollars to get that done.

The time table that Rob was talking to with Rick Shane is, we are currently and hopefully hope to be able to roll that out in February, as we have announced before over the last year.

This has been a year-long project and we are still on time to do that.

As that project -- just to give you an idea of where we we see efficiencies -- in IT costs alone, bringing that loan origination system online will allow us to retire 11 different sub systems that we currently use to support our current loan origination system.

It will also be faster.

It will be fewer screens.

It will be much more interactive.

It will help us on our web originations, and there is a currently a work flow study that we are in process of doing that will help us reduce the number of people touches to get the loan through the system without sacrificing credit quality or compliance issues.

So there's a lot of stuff that we are doing.

Unfortunately, for the marketplace today, they don't see that because there's no premium being paid for doing it right and having lower losses and lower cost of service.

However, we still do see those benefits and as interest rates rise, and as the marketplace begins to suffer a little bit less growth, we may see that the value of the quality of our portfolio will increase relative to the other portfolio in the marketplace.

Okay.

So, the $25 million lower expense goal, are you still sticking with that?

I think if you go off the run rate from December of last year.

Right,.

That we still have the goal to in the month of January of next year be at a 25 million a year lower run rate.

That's still our goal.

So December '04 versus January '06.

That's correct.

Okay and can I ask you a question about the margin?

You guys had -- Rob said that it seems to have stabilized.

And then the higher weighted average coupons are obviously helping out.

Can you give maybe a little more color on that?

Did you see it sequentially during the quarter?

Was the impact in September?

Less --

I would say that sequentially during the quarter, we increased our coupons, however, we were able to -- given to where the market rates were, increase them as much as to the increase to our our short-term costs of funds, okay.

However, during the month of October, which is why we brought up subsequent issues, the market has clearly outpaced the increase in the swap curve, as what's happened is the market leaders that have tended to drive this suicidal pricing over the last several months saw significant reversals in their ability to sell whole loans and profit, or in fact at a loss.

And so rationalality has intruded its cold, hard head and we are seeing that the marketplace has decided we can compete but we got to compete at least at break even or better.

And if the marketplace drives costs or pricing to where they compete at break even, then given our other advantages, we're very happy to start investing again in the portfolio.

But right now until they get to that point, I don't think it makes sense as a businessman to invest in assets that are less than their costs.

So, or worth less than their costs.That's why we have maintained our competitive posture the way we have the last six, seven months.

I'll get back in cue, thanks.

We have a follow-up from Scott Valentin with Friedman, Billings, Ramsey.

Hi, Scott.

Hi, thanks for taking my follow-up.

Okay.

On the credit side, people are obviously nervous about the consumer going into the winter with higher fuel bills and higher interest rates in general.

Can you talk about your outlook when you expect for credit performance?

You said seasonally, you had an increase in delinquencies when is normal in the back half of the year, but you could talk about your outlook?

What you expect.

We're very pleased with where we are at, but I will say that we always try to be pro active.

David has taken his employees per account from 1100 where he's been pretty consistently down to 1,000 in expectation that there will be more phone calls with the higher -- we're looking at some unemployment in the center of the country.

Not everybody that lost his job or house can go help build roofs.

We're looking at increased fuel costs significantly, both fuel oil and natural gas.

And so we have -- we feel prudently staffed -- David's staff up from where he was in the last year and a half about 10% in terms of additional calls per the number of accounts that we have.

So, do I expect to see a severe spike?

Unless the fed becomes extremely aggressive and increases their rate of interest rate adjustments, I don't see that we'll see a spike, What I do think we'll see is the traditional and historically very seasonal decrease in the delinquencies in January, February, March, April, may not go down as much as they have in the past but that's all in the future, Scott, you just don't know.

It really, really in our marketplace.

It's less effected by the unemployment rate than it is by home appreciation, and we too expect home appreciation to slow.

So we expect that delinquencies will respond to that.

As far as the bankruptcy impact -- the normal impact on your business?

Bankruptcy impact our business surprisingly was relatively minimal.

We saw the largest increase in our bankruptcies back in June, between May and June.

And have seen minimal increases since then.

Versus the credit card business, as everybody knows, there was just an unbelievable increase in bankruptcies during the month of October as the law came into effect.

One last question.

Any markets you guys are avoiding in terms of originations with regard to home prices?

No markets in regard to concern about home prices.

Although, we tend to look with a more conservative eye in places where there's been significant appreciation and over the years our underwriters have looked and said time adjustments which are are common.

We do though have a pricing concern in some areas and you've seen that California has continued to be less and less of our origination and our portfolio.

And that's primarily because when we go out there at a minimum, we're going to on our lowest rate best credit product, we're at least going to break even or we're not going to make the loans.

And in California, especially, over the last six months, people have been making loans there at a loss.

We don't think that's a prudent way to invest your capital.

Okay, thank you.

Your final question will be a follow-up from Rick Shane with Jefferies.

Go head, please.

Thanks guys for taking my follow up.

Just wondering, you talked a lot about your LOS.

I'm curious, is it something you're developing internally or something you're buying the third-party off the shelf system?

And are you replacing an internal system or off the shelf system?

We originally went onto the Gallagher system.

It's been five years now?

No, 96.

It's been nine years, since we last did this.

The system we're proceeding to call Net Oxygen is actually about a third or fourth generation of Gallagher.

It is the same database which does help us in terms of implementation, but as can you imagine how the internet and the computer world has changed over the last nine years, we have added all kinds of different add on systems and functions in order to keep our 96 system at least workable and up-to-date.

But whenever you add work arounds, you add processes and that decreases your efficiency.

We made the decision to go to Net Oxygen last year.

It's about a one year process to convert your entire loan origination system, but it is not something we're building inside.

In fact, as I said, we'll be able to retire over 11 different separate sub systems once Net Oxygen is up and rung.

And by the way, they have about a 20% plus market share out there in terms of our competitors.

Okay, great, thank you guys, very much.

Thanks, Rick.

Please go ahead with your closing remarks.

All right, thank you.

Well, first of all, I would like to thank you everybody.

I will be the first to say that we are not happy with our financial results.

I do think that we have prudently managed our investor's capital.

I'm excited about the continued growth and profitability of our servicing business and I'm looking very positively on the way that rationalality has begun to return to the pricing of whole loans in the marketplace.

And as usual, we will be available for one on one calls after the conclusion of the call.

Thank you all, and have a good day.

Thank you and ladies and gentlemen, that does conclude our conference for today.

Thank you for your participation and using AT&T executive teleconference.

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